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The Delicate Art Of Price Hikes

November 05, 2000

Frontier -- What Works

The Delicate Art of Price Hikes

Entrepreneurs are finding they can charge more--without driving away customers

Like most other small companies scrambling for market share, Mi8 Corp. was reluctant to raise prices. But then, the Manhattan application service provider, which rents and services Microsoft server software over the Web, learned that Microsoft Corp. was planning to raise its prices. In response, Mi8 hiked its own rates by 14%. The response? Not one complaint and not one lost customer.

After years of little or no inflation, entrepreneurs are feeling newfound pricing power. A net 13% of small companies reported raising prices in September, compared with just 8% a year earlier, according to the National Federation of Independent Business. The challenge for entrepreneurs is how to flex that muscle without battering your customers. Mi8 offered customers a 90-day grace period and also gave them the chance to lock in a lower rate--if they signed a yearlong contract. Few took the offer. "Most seemed to want to go month to month, even if it meant paying more," says Patrick Fetterman, vice-president for marketing.

That's a lesson many small companies never learn, says Al Osborne, director of the Price Center for Entrepreneurial Studies at the University of California at Los Angeles. "If you establish a niche, you can charge whatever the market will bear," he says. But instead of basing prices on market conditions, many entrepreneurs let their costs drive their prices, he says.

Still, a little finesse goes a long way. Pompanoosuc Mills Corp., a furniture maker in East Thetford, Vt., raised its prices 7% in May in response to rising costs of labor and raw materials. The company alerted customers by sending out postcards. Since raising prices, the company hasn't heard any complaints, says Rob Chapin, Pompanoosuc's director of marketing. "We try to hold the line, but we needed to keep our margins," he says.

Even heftier increases can be palatable if presented the right way. In June, Berland Technology Inc., a custom-software developer in Culver City, Calif., raised its hourly rates 50%, to $225 an hour. The move was largely dictated by the higher salaries the company pays its 40 employees. To cushion the blow, Berland offered to complete any work in progress at the old rate. Those who balked were permitted to switch to a flat fee, rather than an hourly rate. "Some customers just seem to feel better with a fixed price," says Executive Vice-President Bill Craig. The result? Nobody jumped ship.

The most important thing is to be decisive. "The market will allow you to raise your prices this year, but it may not let you do it again for another five years," says UCLA's Osborne. Just be gentle: Customers bruise easily.By Michelle LederReturn to top

ONLINE EXTRA

Figuring the Right Time to Raise Prices

It could be now, says UCLA's Al Osborne, who tells entrepreneurs not be afraid to charge "what your customers are willing to pay"

After years of little or no inflation, a growing number of entrepreneurs are finally able to push through price increases. But while the strong economy has made it easier to hike prices, many small-business owners remain wary of doing so. That's a mistake, says Al Osborne, director of the Price Center for Entrepreneurial Studies at the University of California at Los Angeles. If you want your margins to remain healthy, you have to keep a close eye on what you charge, he says. Osborne recently spoke with Business Week frontier's Michelle Leder. Edited excerpts from their conversation follow:Q: How can a small business figure out when it's a good time to raise prices?

A: So many small companies forget that prices are a function of what your customers are willing to pay. One of the neat things about small companies -- as opposed to big companies that frequently have big competition -- is that if you have a service or a product that solves a need, you can charge more. Q: Should small businesses raise their prices automatically once a year?

A: Not necessarily. A lot of small businesses raise their prices because their own costs are going up. But that's not the right way. It may cost you more to hire talent, but that doesn't mean your product is any better. Frequency should really depend on the demand for your product. If a lot of people want to buy your product or solution, you can charge what the market will bear. And remember: The market may allow you to raise your prices this year, but may not let you do it again for another five years.Q: What's the biggest mistake entrepreneurs make when it comes to raising prices?

A: Most are too afraid to do it. A lot of small companies are unsophisticated and they don't understand what their customers are willing to pay and what they can pay.Return to top